Inflation Targeting in India : An Interim Assessment

Gupta, Poonam and Eichengreen, Barry and Choudhary, Rishabh (2021): Inflation Targeting in India : An Interim Assessment. Published in: World Bank Policy Research Working Paper Series No. 9422

Abstract

This paper provides an assessment of India’s inflation-targeting regime. It shows that the Reserve Bank of India is best characterized as a flexible inflation targeter: contrary to criticism, it does not neglect changes in the output gap when setting policy rates. The paper does not find that the Reserve Bank of India became more hawkish following the transition to inflation-targeting; to the contrary, adjusting for inflation and the output gap, policy rates became lower, not higher. Some evidence suggests that inflation has become better anchored: increases in actual inflation do less to excite inflation expectations, indicative of improved anti-inflation credibility. The question is whether the shift to inflation-targeting has enhanced the credibility of monetary policy such that the Reserve Bank of India is in a position to take extraordinary action in response to the Covid-19 crisis. The paper argues that the rules and understandings governing inflation-targeting regimes come with escape clauses allowing central banks to shelve their inflation targets temporarily, under specific circumstances satisfied by the Covid-19 pandemic. The paper provides evidence that inflation-targeting central banks were able to respond more forcefully to the Covid-19 crisis, consistent with the idea that inflation expectations were better anchored, providing more policy room for maneuver.

• Item Type: MPRA Paper
• Language: English
• Keywords: Inflation targeting, Monetary policy, India
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

Acharya, Viral (2017), “Monetary Transmission in India: Why is It Important and Why Hasn’t it Worked Well?” Inaugural Aveek Guha Memorial Lecture, Tata Institute of Fundamental Research (16 November).

Andrews, Donald W.K. and Hong-Yuan Chen (1994), “Approximately Median-Unbiased Estimation of Autoregressive Models,” Journal of Business and Economic Statistics 12, pp.187-204.

Asnani, Swati, Pankaj Kumar, and Shekhar Tomar (2019), “Does Inflation Targeting Anchor Inflation Expectations? Evidence from India.”

Athey, Susan, Andrew Atkeson and Patrick Kehoe (2005), “The Optimal Degree of Discretion in Monetary Policy,” Econometrica 73, pp.1431-1475.

Ball, Lawrence, M., Anusha Chari and Prachi Mishra (2016), “Understanding Inflation in India,” India Policy Forum 12, pp.1-45.

Ball, Lawrence, M., and Niamh Sheridan (2005), “Does Inflation Targeting Matter?” In B. Bernanke and M. Woodford (Eds.), The Inflation Targeting Debate. Chicago and London: University of Chicago Press.

Basu, Kaushik, Barry Eichengreen and Poonam Gupta (2015), "From Tapering to Tightening: The Impact of the Fed’s Exit on India," India Policy Forum, National Council of Applied Economic Research, vol. 11, pp.1-66.

Batini, Nicoletta and Douglas Laxton (2007), “Under what Conditions can Inflation Targeting be Adopted? The Experience of Emerging Markets”, In F. Mishkin, N. Loayza and K. Schmidt-Hebbel (Eds.), Monetary Policy under Inflation Targeting. Santiago: Central Bank of Chile.

Bhoi, Barendra Kumar ,Abhishek Kumar and Prashant Mehul Parab (2019), “Aggregate Demand Management, Policy Errors and Optimal Monetary Policy in India,” IGIDR Working Paper no.2019-029.

Brito, Ricardo D. and Brianne Bystedt. (2010), “Inflation Targeting in Emerging Economies: Panel Evidence,” Journal of Development Economics 1, pp.198–210.

Calderón, Cesar and Klaus Schmidt-Hebbel (2010), “What Drives Inflation in the World?” In R. Fry, C. Jones and C. Kent (eds.), Inflation in an Era of Relative Price Shocks. Reserve Bank of Australia and Centre for Applied Macroeconomic Analysis of The Australia National University.

Cashin, Paul and Rahul Anand (2016), “Reconsidering the Role of Food Prices in Inflation,” in Taming Indian Inflation, USA: Rawat Publication. Available from: IMF eLibrary.

Chhibber, Ajay (2020), “With Food and Fuel Consumer Price Index Surges, it’s Time to Rethink the Inflation Target Regime,” Economic Times (24 January).

Cogley, Timothy and Argia M. Sbordone (2008), “Trend Inflation, Indexation, and Inflation Persistence in the New Keynesian Phillips Curve,” American Economic Review, 98, pp.2102– 2126.

Das, Shaktikanta (2020), “Seven Ages of India’s Monetary Policy,” Reserve Bank of India Governor’s Speech (24th January 2020).

Dua, Pami (2020), “Monetary Policy Framework in India,” India Economic Review, 55, pp 117–154.

Fuhrer, Jeffrey C. (2010), “Inflation Persistence,” Handbook of Monetary Economics, New York: North Holland, Volume 3, pp. 423-486.

Gemayel, Edward R., Sarwat Jahan and Alexandra Peter (2011), “What Can Low-Income Countries Expect from Adopting Inflation Targeting?” IMF Working Paper WP/11/276, November.

Gonçalves, Carlos Eduardo S. and João M. Salles (2008), “Inflation Targeting in Emerging Economies: What Do the Data Say?” Journal of Development Economics 85, pp 312–318.

Grossman, Herschel and John Van Huyck (1988), “Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation,” American Economic Review 78, pp.1088-1097.

Heenan, Geoffrey, Marcel Peter and Scott Roger (2006), “Implementing Inflation Targeting: Institutional Arrangements, Target Design and Communications,” IMF Working Paper WP/06/278.

Hutchison, Michael, Rajeswari Sengupta and Nirvikar Singh (2010), “Estimating a Monetary Policy Rule for India,” Economic and Political Weekly xlv (38) (September 18).

Hutchison, Michael, Rajeswari Sengupta and Nirvikar Singh (2013), "Dove or Hawk? Characterizing Monetary Policy Regime Switches in India," Emerging Markets Review 16(C), pp.183-202.

Inoue, Takeshi and Shigeyuki Hamori (2009), "An Empirical Analysis of the Monetary Policy Reaction Function in India," IDE Discussion Papers 200, Institute of Developing Economies, Japan External Trade Organization (JETRO).

Kose, Ayhan, M., Hideaki Matsuoka, Ugo Panizza, and Dana Vorisek (2019), “Inflation Expectations: Review and Evidence,” World Bank Policy Research Paper no. 8785.

Kumawat, Lokendra and N.R. Bhanumurthy, N. R. (2016), "Regime Shifts in India's Monetary Policy Response Function," Working Paper 16/177, National Institute of Public Finance and Policy.

Lin, Shu and Haichun Ye (2007), “Does Inflation Targeting Really Make a Difference? Evaluating the Treatment Effect of Inflation Targeting in Seven Industrial Countries”, Journal of Monetary Economics 54, pp.2521–2533.

Mishkin, Frederic S. and Klaus. Schmidt-Hebbel (2007), “Does Inflation Targeting make a Difference?” In F. Mishkin, N. Loayza and K. Schmidt-Hebbel (Eds.), Monetary Policy under Inflation Targeting, Santiago: Central Bank of Chile.

Mishra, Prachi and Devesh Roy 2012. “Explaining Inflation in India: The Role of Food Prices,” India Policy Forum.8, pp.139-223.

Mishra, Prachi, Peter Montiel and Rajeswari Sengupta (2016), “Monetary Transmission in Developing Countries,” Evidence from India, IMF Working Paper no.16/167 (December).

Mohan, Rakesh and Muneesh Kapur (2009), “Managing the Impossible Trinity: Volatile Capital Flows and Indian Monetary Policy”, Stanford University, SCID Working Paper No. 401.

Mohan, Rakesh and Partha Ray (2018), “Indian Monetary Policy in the Time of Inflation Targeting and Demonetization”, Brookings India, Working paper no.4.

Mohanty, Deepak (2014), “Why is recent food inflation in India so persistent?” Speech delivered at the St. Xavier’s College, Mumbai, 13 January 2014.

Mohanty, Madhusudan and Marc Klau (2004), “Monetary Policy Rules in Emerging Market Economies: Issues and Evidence,” BIS Working Paper No 149, Basel: Bank for International Settlements.

Naqvi, Bushra, and Rizvi, Syed Kumail Abbas (2009), “Inflation Targeting Framework: Is the story different for Asian Economies?” MPRA Paper 19546, University Library of Munich, Germany.

JPMorgan (2018), “Is inflation dead? A discussion”, Economic Research, April 2018.

Obstfeld, Maurice (1997), “Destabilizing Effects of Exchange-Rate Escape Clauses,” Journal of International Economics 43, pp.61-77.

Patnaik Ila, and Radhika Pandey, 2020, “Moving to Inflation Targeting”, NIPFP working paper 316.

Patra, Michael, D. and Muneesh Kapur (2012), “Alternative Monetary Policy Rules for India”, IMF Working Paper. (No.118, IMF).

Patra, Michael, D. J. K. Khundrakpam, and A. T. George (2014), “Post-Global Crisis Inflation Dynamics in India: What has Changed?”, India Policy Forum.

Pivetta, Frederica and Ricardo Reis (2007), “The Persistence of Inflation in the United States. Journal of Economic Dynamics and Control 31, pp. 1326–1358.

Pontines, Victor (2011), "The Nexus Between Inflation Targeting and Exchange Rate Volatility," Staff Papers, South East Asian Central Banks (SEACEN) Research and Training Centre, number sp84.

Raj, Janak, Sangita Misra, Asish Thomas George and Joice John (2020), “Core Inflation Measures in India: An Empirical Evaluation using CPI Data,” RBI Working Paper 05 (May 12).

Rangarajan, Chakravarty (2020), “The New Monetary Policy Framework –What it Means,” NIPFP Working Paper Series, No. 297.

Reserve Bank of India (2014), “Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework,” Chairman: Dr. Urjit Patel, Mumbai: Reserve Bank of India.

Rose, Andrew (2007), “A Stable International Monetary System Emerges: Inflation Targeting is Bretton Woods Reversed,” Journal of International Money and Finance 26, pp.663–681.

Singh, Bhupal (2010), “Monetary Policy Behaviour in India: Evidence from Taylor-Type Policy Frameworks,” Reserve Bank of India, Staff Study SS (DEAP): 2/2010.

Stock, James and Mark Watson (2007), “Has Inflation Become Harder to Forecast?” Journal of Money, Credit and Banking 39, pp.3–34.

Vega, Marco and Diego Winkelried (2005), “Inflation Targeting and Inflation Behavior: A Successful Story?” International Journal of Central Banking vol. 1 (3), pp.153–175.

Virmani, Arvind (2004), “Operationalizing Taylor-Type Rules for the Indian Economy,” Technical Report. Indian Institute of Management, Ahmedabad.

Woodford, Michael (2001), “The Taylor Rule and Optimal Monetary Policy,” American Economic Review 91, pp.232–237.